The debt service coverage ratio is only one of the many factors considered to determine if a business owner like you can take on a loan. Still, this ratio can tell a lot about your future financial value.
In this article you’ll learn everything you need to know about this valuable business measurement.
What is Debt Service Coverage Ratio?
The debt service coverage ratio (or DSCR) is the ratio of operating income available to debt servicing for interest, principal, and lease payments.
The DSCR is also known as the “debt coverage ratio”
Different Types of DSCR
There are two types of Debt Service Coverage Ratio:
- Gross Debt Service Coverage Ratio (GDS)
- Total Debt Service Coverage Ratio (TDS)
When you apply for a business loan, both debt service coverage ratios are used as a preliminary assessment to determine if you are already in debt.
In other words, your lender has to evaluate the risk involved in lending you money and the probabilities you have to fall behind your payments, and part of this evaluation will be based on your ratios. If you fall below a particular percentage, you’ll be considered as a no-risk borrower and you’ll have more chances to get a business loan.
What’s important is to stay transparent during the loan process and provide all your financial information to your lender.
How Do You Calculate the Debt Service Ratio?
It’s important to learn how to properly calculate DSCR, GDS, and TDS to obtain a percentage as a general benchmark.
Debt Service Coverage Ratio Formula
The debt service coverage ratio (DSCR) is defined as net operating income divided by total debt service.
DSCR = Net Operating Income / Total Debt Service
What is a good DSCR?
A good DSCR depends on your industry, as not every business is the same, but as a good rule of thumb, having a DSCR above 1.25 is good, but if it’s below 1.00 it means you probably have financial difficulties.
Gross Debt Service Ratio Formula
To determine your GDS, you’ll need to add all of your monthly housing-related costs (mortgage, monthly property houses, HOA fees if applicable, etc.) and divide it by your gross monthly income. Then multiply that sum by 100 and you’ll have your GDS ratio.
GDS = ( Monthly housing-related costs / Gross monthly income ) x 100
This percentage shows your current debt issues.
What is a good GDS?
Lenders use the GDS as just a framework on whether it’s appropriate to lend to people like you.
Favorably, this number should fall below 30% to prove you’re not overwhelmed with debts. Even just a few percentage points above this can mean you have far too many unacceptable expenses at the moment to safely borrow from a lender.
For instance, if you have to pay over $12,000 a year in mortgage and several thousand dollars per year in property taxes, you’ll need to have an income falling above $50,000 or more to avoid going into debt. A lower income will be a red flag for a business loan.
Total Debt Service Ratio Fromula
Your TDS ratio is the percentage of your income needed to cover all of your debts. The debt ratio formula calculation is the same as that of the GDS, except all of your monthly debts are taken into consideration. This includes car payments, credit cards, alimony, and any loans.
To calculate your TDS ratio, add all of your monthly debts and divide that figure by your gross monthly income. Then multiply that sum by 100 and you’ll have your TDS ratio.
TDS = ( Monthly debts / Gross monthly income ) x 100
What is a good TDS?
On the total debt service ratio, you need to fall under 40% in order to properly qualify for a loan.
Again, though, the 30% on GDS and 40% on TDS are just guidelines. They don’t mean you already have good credit. If you do have a good credit score, you’ll have more chances to be approved for a loan, based on the fact that you haven’t defaulted on any prior loans or credit card debt.
How Do We Use the Debt Service Coverage Ratio at Camino?
This ratio is not the only thing you need to get a loan, there are many other factors to consider: perhaps your current career has income growth potential, or you can show proof your new business would provide exponential revenue soon.
With these things in mind and based on favorable future income, lenders may still want to lend to you even if your GDS is not favorable. In other words, there are other detailed criteria that lenders take into consideration to decide if you can safely take on a business loan.
At Camino Financial we use the debt service ratio often to evaluate business loan applications. Doing so makes our small business lending process faster. But what we really care about is you and your business.
With Camino, you can receive your funds in just a few days. You can instantly know if you prequalify for one of our small business loans by submitting an online application. Submitting your application will take you just a few minutes and it won’t affect your credit. If you pre-qualify, a business loan specialist will contact you to guide you through the whole loan process.
Think you’re in a good place to take on a business loan?